Calling the police can be dangerous. New Jersey is doing something about it. The state created a program called ARRIVE Together. A mental health professional accompanies the police when they go out on a call involving someone in mental distress. A study showed that in 342 such cases, only 3% resulted in the use of force and only 2% resulted in an arrest (usually because of an unrelated issue, such as an outstanding warrant). The program is being expanded and should serve as a model for police departments around the country (see this report from the Brookings Institution).

So much for some good news. Now back to harsh reality. From The Guardian:

One of the most deeply held and frequently heard propositions about capitalism is that it revolves around private companies and individuals taking risks. When, earlier this year, the US government arranged a rescue package for Silicon Valley Bank, for instance, among the many objections to it was the claim that the rescue contravened capitalism’s risk norms.

This view of the world directly informs wide swaths of economic policymaking today….But examine the economy, and it becomes clear: capitalism has become less and less about corporate risk-taking in recent decades. To be sure, many businesses do take significant risks. The independent small business owner who opens a new cafe in London generally faces intense competition and massive risk. But as political scientist Jacob Hacker has argued, business in general has been enormously skilled in recent times at offloading risk – principally by dumping it on those least able to bear it: ordinary households.

… The best example of a business usually regarded as being fundamentally about risk-taking, but which in fact is not, is … alternative asset management, an umbrella term for hedge funds, private equity and the like. (“Alternative” here means anything other than publicly listed stocks and bonds.) Asset managers are anything but marginal, exotic firms – they manage more than $100 trillion of clients’ money globally and control everything from [Benihana to PetSmart to Westinghouse].

But let’s look at what asset management companies in places like Britain and the US actually do. Three considerations are paramount.

First, there is the matter of whose capital is put at risk when alternative asset managers such as Citadel, Blackstone and KKR invest. In large part, it’s not theirs. The proportion of equity invested by a typical hedge or private equity fund that is the asset manager’s own is usually between 1% and 3%. The rest is that of their external investor clients (the “limited partners”), which include pension funds.

Second, consider how an asset manager’s investments are designed. For one thing, its own financial participation in, and management of, its investment funds is usually through a vehicle (the “general partnership”) that is constituted as a separate entity, precisely in order to insulate the firm and its professionals from liability risk.

Furthermore, the fund and its manager is generally distanced from underlying investments by a chain of intermediary holding companies that protect it from the risk inherent in those investments. In leveraged buyouts, where money is borrowed to help finance a deal,the debt goes on to the balance sheet of the company the fund has acquired. This means if trouble arises in repaying the debt, it is not the investment fund that is on the hook, still less its manager.

Third and last, fee structures also distance asset managers from risk. If a fund underperforms, they may earn no performance fee (based on fund profits), but they do have the considerable consolation – a form of risk insurance, if you like – of the guaranteed management fee, usually representing about 2% of limited partners’ committed capital, year after year. Essentially, management fees pay asset managers’ base salaries; performance fees pay bonuses.

In short, then, it would be far-fetched to suggest that what hedge funds and the like do amounts substantially to risk-taking. The only meaningful risk they themselves face is that of losing customers if fund returns prove underwhelming…. In reality, the business of alternative asset management is less about taking on risk than, in Hacker’s terms, moving it elsewhere. So when things go wrong, others bear the brunt….

Why does this matter? Because unless elected policymakers understand how risk is produced and distributed in modern economies, they will not be in a position to act appropriately and proportionately. That is why vague talk from politicians of being “pro-business” or “entrepreneurship” mean so little; the point is to learn from economic realities as they actually are, as opposed to how economics textbooks say they could or should be.

There is one very obvious policy recommendation for alternative asset management that flows from our understanding what they actually do with “risk”: taxing them more.

The main performance fee earned by alternative asset managers is “carried interest” – effectively, a profit share. In the UK and US, most asset management firms pay tax on this revenue at the capital gains rate, rather than the usually higher income tax rate. This is because the asset manager has typically been understood to be “taking on the entrepreneurial risk of the [investment]” – a standard justification for taxation as capital gain.

But as we have seen, this simply does not hold water. In 2017, the New York Times called the beneficial tax treatment of carried interest “a tax loophole for the rich that just won’t die”. It’s time to close it….

Note: To pass Biden’s Inflation Reduction Act last year, Democrats needed Sen. Kyrsten Sinema’s vote. But she wouldn’t vote for the bill unless Democrats dropped the provision that would have closed the carried interest loophole. She insisted on preserving the tax break that favors the securities and investment industry. Wouldn’t you know that hedge fund managers and private equity executives gave her more than $2 million between 2018 and 2022? Since then, she left the Democratic Party to run in Arizona as an “Independent” [CNBC].